Mandelson right to be wary of Obama’s bank proposals

With President Obama sending legislative wording of his much vaunted ‘Volcker’ proposals to the US Congress this week, the debate surronding its controversial reform measures erupted once again.

Speaking from New York, business secretary Lord Mandelson said the proposals were over-ambitious:

“Trying to apply sweeping rules about the structure, content and range of activities of banking entities is too difficult to do.”

He instead argued for greater focus to be placed on securing an effective international regulatory system co-ordinated by members of the G20.

The so-called “Volcker rule” is the brainchild of the former US Federal Reserve chairman and now Whitehouse economic policy adviser Paul Volcker. At its heart is the plan to stop retail and commercial banking from being exposed to speculative financial markets.

This will be achieved through limiting the size of banks and separating their investment banking ‘casino’ activities from day-to-day depository banking. Banks in future would be barred from engaging in ‘proprietary trading’, which involves firms betting on financial markets with their own money, rather than simply carrying out a trade for a client in which their money is only at risk.

Mandelson’s gentle critique of these measures was correct for several reasons:

Firstly, they detract attention and focus away from global efforts in agreeing a regulatory framework for the financial system. A multi-national approach is already being considered and debated by the G20. Any possible agreement that can be secured by the biggest and wealthiest nations in the world must be the main priority.

Secondly, the Volcker proposals will not necessarily “de-risk” the financial markets. They will succeed in safeguarding the financial integrity of retail depository banking, however despite the separation, “casino2 style investment banking will still take place and be an integral part of the financial system.

And with the volume of trading of these firms remaining high, the financial markets and thus wider economy will still be at risk. Effective regulation, firewalls, and “living wills” are the key to shielding the markets. These measures are currently being pursued by the government.

Also, a serious practical consideration that has been neglected is the current state of the banking world. Many countries, at the height of the financial crisis, poured in billions to rescue and save their biggest banks. Taxpayers all around the world have large stakes in their nations’ banks. Profitable trading operations underpin large parts of their activities.

To separate these divisions has the potential to seriously de-value shares, and thus taxpayers’ equity. Questions remain too, whether Obama’s measures would have fully protected even the US economy during the financial crisis, with Peter Morici of the University of Maryland arguing:

“Smaller US banks got into trouble buying mortgage-backed securities and putting them on their books – this isn’t prevented by a ban on proprietary trading.“

As one can see, the jury is still clearly out on “Volckers law”.